Is Guangdong Kanghua Healthcare (HKG:3689) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Guangdong Kanghua Healthcare Co., Ltd. (HKG:3689) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Guangdong Kanghua Healthcare

What Is Guangdong Kanghua Healthcare's Net Debt?

As you can see below, at the end of December 2020, Guangdong Kanghua Healthcare had CN¥276.7m of debt, up from CN¥216.3m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥584.7m in cash, so it actually has CN¥308.0m net cash.

How Strong Is Guangdong Kanghua Healthcare's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Kanghua Healthcare had liabilities of CN¥596.9m falling due within a year, and liabilities of CN¥449.5m due beyond that. On the other hand, it had cash of CN¥584.7m and CN¥232.2m worth of receivables due within a year. So it has liabilities totalling CN¥229.5m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Guangdong Kanghua Healthcare has a market capitalization of CN¥894.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Guangdong Kanghua Healthcare boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Guangdong Kanghua Healthcare if management cannot prevent a repeat of the 76% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Guangdong Kanghua Healthcare will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Guangdong Kanghua Healthcare may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Guangdong Kanghua Healthcare reported free cash flow worth 20% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While Guangdong Kanghua Healthcare does have more liabilities than liquid assets, it also has net cash of CN¥308.0m. So while Guangdong Kanghua Healthcare does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Guangdong Kanghua Healthcare has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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